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Intermediate Accounting, Volume 2, Seventh
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Chapter 13: Financial Instruments: Long-term Debt

Case 13-1 Forestry Incorporated
13-2 Huy Publications Limited
13-3 Dry Clean Depot Limited
Suggested Time
Technical Review
TR13-1 Financial instruments: long term debt (IFRS).. 5
TR13-2 Financial instruments: long term debt (ASPE) 5
TR13-3 Debt present value............................................ 10
TR13-4 Debt present value............................................ 10
TR13-5 Interest expense, straight line........................... 10
TR13-6 Interest expense, effective interest ................... 10
TR13-7 Debt issuance costs .......................................... 10
TR13-8 Borrowing costs ............................................... 5
TR13-9 Debt retirement ................................................ 10
TR13-10 Foreign exchange ............................................. 10

Assignment A13-1 Sources of financing......................................... 10

A13-2 Sources of financing......................................... 10
A13-3 Sources of financing......................................... 10
A13-4 Debt issuance, fair value .................................. 20
A13-5 Debt issuance, interest expense…………….... 20
A13-6 Interest expense................................................ 20
A13-7 Interest expense (*W) ...................................... 30
A13-8 Interest expense................................................ 30
A13-9 Bond issuance and interest expense ................. 25
A13-10 Bonds issued between interest dates (*W)....... 30
A13-11 Bonds issued between interest dates ................ 30
A13-12 Bonds issued between interest dates ............... 40
A13-13 Debt issuance costs .......................................... 20
A13-14 Debt issuance costs .......................................... 20
A13-15 Foreign currency .............................................. 20
A13-16 Foreign currency (*W) ..................................... 20
A13-17 Borrowing costs ............................................... 20
A13-18 Borrowing costs ............................................... 25
A13-19 Borrowing costs ............................................... 25
A13-20 Debt retirement – open market purchase ......... 25
A13-21 Debt retirement (*W) .......................................
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A13-24 Debt issuance and retirement, accrued interest 40
A13-25 Debt issuance, defeasance................................ 30
 A13-28 ASPE: Straight-line amortization .................... 20
A13-29 ASPE: Straight-line amortization ................... 20
A13-30 ASPE: Comprehensive, straight-line amortization 40

*W The solution to this assignment is on the text website, Connect.

The solution is marked WEB.

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Cases

Case 13-1
Forestry Incorporated

To: Board
From: Accounting Advisor

Currently, you are using ASPE for your accounting policies. You have asked me to identify
the differences in adopting IFRS which would be necessary if you decide to go public or
accept the offer from the public company. IFRS allows more choices for measurement but
will be more costly and complex.

You have a number of objectives to consider in selecting your accounting policies.

Employees have a stock option based on net income so they will be interested in
maximizing net income. The bank is interested in your future cash flows and ability to
repay your loan. The new loan does not have the restriction on the payment of dividends
however, there is a maximum debt to equity ratio. To avoid loan repayment, you would
want to ensure this covenant is met. The bank requires audited financial statements. This
will also be required if you decide to go public. The owners are interested in selling or
going public therefore they will be interested in strong financial statements.

Issues

1) Bank loans
2) Lawsuit
3) Construction new sawmill
4) Long term supply contracts
5) Revenue recognition lumber
6) Reforestation
7) Lumber
8) Bonds

Analysis and Conclusions

1) Bank loans

FI has replaced their previous bank loan with a new loan. Since the terms and the amount
has changed this is considered a substantial modification and the original loan is
derecognized in both IFRS and ASPE. The unamortized transaction costs and financing
fees from the old loan will be expensed since that loan will now be derecognized. In ASPE
the loan could be measured using amortized cost or we could elect to measure at fair value.
To be consistent with past treatment I recommend we use amortized cost. The

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$1.2 million of new transaction costs would be capitalized to the loan which will reduce
the value of the loan. There is a choice to use the straight line method or the effective
interest method for amortization. I recommend we use the effective interest method since
it is required in IFRS as discussed below.
In IFRS it must be decided if the new loan will be classified as FVTPL or other
liabilities. Since the previous loan used amortized cost it was in other liabilities. To be
consistent I recommend the same classification. If the effective interest method is
selected in ASPE there will be no changes then required if FI decides to use IFRS in the
future.

2) Lawsuit

In ASPE we must determine if the lawsuit is likely and if it can be measured. It is likely
since medical studies support their claims that the residents will be successful. FI will need
to contact their lawyers to see if an estimate can be made for the amount of the claim.
I assume that they would be able to look at past lawsuits to determine an amount. I
recommend this amount be accrued with note disclosure. In IFRS we would look to
determine if the lawsuit was probable which would also be met. There would be the same
treatment.

Note: Students could have also concluded that the lawsuit was in early stages and it would
not be possible to estimate an amount and only note disclosure would be provided.

3) Construction new sawmill

The new sawmill would be a self constructed asset. The costs of $6 million associated with
construction should be capitalized to the asset. In ASPE FI has a choice to expense or
capitalize the interest costs associated with construction costs for any specific loans taken
out for the project. Capitalization would stop when the strike is on and restart when the
strike is over. I recommend that construction cost be capitalized to be consistent with IFRS
and minimize any changes if FI decides to convert to IFRS. FI will be required to have
note disclosure of the amount of interest costs capitalized.

In IFRS the construction of the sawmill would be considered a qualifying asset since it will
take a year and a half which would be a substantial amount of time to complete. Similar to
above the interest costs would be capitalized but this would stop during the strike. IFRS
would capitalize both specific loans and general loans if also used for construction.

4) Long term supply contracts

In ASPE it must be determined if the anticipated penalty costs meet the definition of a
liability. FI has not been able to meet the demand related to the contract and anticipate a

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future sacrifice of $250,000. They are required to make the payment based on the
contract and it can be measured based on the contract. Therefore, FI should accrue an
estimated liability for this amount.

In IFRS this would be considered an onerous contract if the cost of the penalties of
$250,000 exceed the benefits of the contract. Similar to ASPE the $250,000 should be
accrued as a provision assuming this amount exceeds the benefits associated with the
contract.

5) Revenue recognition lumber

In ASPE we must determine when there is a transfer of risks and rewards. For the sale to
the lumber centres performance would be met when the lumber is delivered to the centre.
Even though payment is not received for 30 days FI would have history to be able to
estimate bad debts. Revenue therefore, would be recognized on delivery to the centre
with an allowance established based on past history for bad debts.

For the sales to the agents the contract would be the sale of the lumber to their customers
not to the agents. It should be considered if FI is the principal or the agent and if net
versus gross revenue should be recognized. FI would be the agent since even though they
pay a set amount to their oversea agents FI would control the price, they would have
inventory risk, they are responsible for fulfilling the contract. The fee paid to the agents
would be recognized as an expense by FI.

In IFRS for the sales to the lumber centres. The contract would be the sale of the lumber
to the lumber centres. There is one performance obligation which is the delivery of the
lumber to the centre. The overall contract price would be the amount that the lumber centres
pay. Since FI has been in business a number of years they would be able to estimate bad
debt expense. The performance obligation would be satisfied when the lumber is delivered
to the centres. This would be the same treatment as in ASPE.

For the sales to the agents the contract would be the sale of the lumber to their customers
not to the agents. Similar to the centres it is one performance obligation. Similar to in
ASPE it should be considered if FI is the principal or the agent and if net versus gross
revenue should be recognized. This would be the same treatment as in ASPE.

6) Reforestation

In ASPE the requirement to reforest the lands would be considered an asset retirement
obligation. This would be measured at the PV of the $2.5 million (15 years, 10%) =
$598,475. This amount would be added to the value of the timber and a liability would
be set up for the same amount. At the end of the year depreciation expense would be

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recognized of $598,475 / 15 = $39,898. Interest expense would also be recognized for
$598,475 x 10% = $59,848.

FI would have a similar treatment in IFRS for the reforestation costs. They would set up
a decommissioning provision for the same amount as above. What would be different in
ASPE would be the treatment of the timber. While the trees are growing they would be
considered a biological asset. In IFRS the trees would be recorded using the fair value
model which is fair value less costs of sale every reporting date and the gains or losses
would be recognized in net income. When the trees are cut they would be agricultural
produce. Once the timber is transformed it would be transformed into inventory and
measured at the lower of cost and net realizable value. ASPE does not allow the use of
the fair value model for biological assets.

7) Lumber

In ASPE the timber would be inventory and measured at the lower of cost and net
realizable value. The timber would be written down to $1 million and an impairment loss
would be recognized for $4 million.

The treatment would be similar in IFRS.

8) Bonds

The bonds would be measured at fair value on initial recognition. This would be the present
value.

$10,000,000 (10 periods, 5%) (.61391) = $6,139,100

$ 400,000 (10 periods, 5%) (7.72173) = 3,088,692
$9,227,792

The bond has been issued at a discount. The bond would be recorded as :

Cash 9,227,792
Discount 772,208
Bond Payable 10,000,000

The discount would then be amortized either using the straight line method or the
effective interest method. I recommend that the effective interest method be used since
this would be required if FI adopted IFRS.

IFRS would require the same accounting for the bond.

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Case 13-2
Huy Publications Ltd.

Overview

Huy Publications Ltd. (HPL) operates in a risky industry, k n o w n f o r its business

failures. While HPL itself is reportedly stable, they have had loss years and
have new facilities and new debt (government-guaranteed) in addition to that
described. Reporting healthy, stable annual profits must be a concern in such an
environment, as is complying with any and all debt covenants, some of which are
based on financial statement information. Lenders would require GAAP-based
financial statements, since covenants are calculated from audited information.
ASPE versus IFRS has not been specified, but ASPE seems logical considering the size
of the company. The ethics of choice are important here, as there might be
temptation to pick an alternative that artificially creates acceptable results for key
users. Financial position must be accurately portrayed.

Issue

Evaluation of loan alternatives

Analysis and Conclusions

Alternative 1 – Canadian Bank

a) The effective interest rate is 8.225% (solved by spreadsheet) over the ten-year
life of the loan, after factoring in the $19,000 u p -front fee and the $5,500
transaction fees. The interest rate is fixed for the ten-year life.
b) Principal need not be repaid until the end of the loan, allowing HPL flexibility in
arranging either operating cash flow to finance the repayment or refinancing
through another borrowing arrangement.
c) HPL would have to switch current banking activities to Canadian Bank away from
their current bank, which may not be attractive.
d) The loan requires corporate guarantees but also personal guarantees from HPL's
shareholders, which may be particularly unwelcome in this risky business sector.
e) Debt: equity ratios must be kept at 2:1, but dividends can be up to 30% of
e a r n i n gs ; current levels are only 10-15% of earnings. The debt: equity
covenant may be viewed as reasonably restrictive; the dividend covenant less so.

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 Alternative 2 – Ottawa Bank

a) The interest rate for the first five years (6.5%) is lower than the interest rate
for Alternative 1. If the up-front fee is factored in (over ten years), the loan
would have to bear a stated interest rate of 10.5% (solved by spreadsheet) over
the second five years in order to have an overall cost equivalent to Alternative 1.
Will the interest rate in the second five-year period be below 10.5% or above
10.5%? Accurate response to this question will tell HPL which alternative is
cheaper, but interest rates are notoriously unpredictable.
b) The up-front fee is considerably larger, which is less attractive to HPL.
c) The debt covenants are more restrictive for HPL, requiring that no new long-
term debt be issued and that dividends not exceed current percentages of income.
d) Corporate security is quite similar to Alternative 1, but also requires a
floating charge on all corporate assets. Significantly, no personal guarantee
is required, which may be a major factor for HPL.
e) Principal payment is not required until the end of the term.

Alternative 3 - Pension fund bond

a) The effective interest rate on this loan is 8.2% (solved by spreadsheet),

considering both the fact that the interest is compounded semi-annually and
there are $227,500 in legal, etc. fees paid up front. The loan cost is fixed over
the life on the loan.
b) The security is the least onerous for any alternative; general credit rating only.
c) The covenants are severe (no dividends unless current ratio is 3.5 or above after
declaration, no repurchase or issue of common shares, restrictions on current
ratio and debt ratios, no changes in management, etc.)
d) HPL would have to agree to put a representative of the lender on their
Board, which is potentially undesirable.
e) Upfront fees are high, which is less attractive to HPL because less net cash is
available at the beginning of the loan period.

Conclusion

When comparing these alternatives, the cost of borrowing must be revised to include
fees and transaction costs so that comparisons are fair and complete.
Senior management of HPL must prioritize the factors that are different for these loans.
Cost of borrowing, future interest rates, restrictive covenants, personal guarantees,
security, and a position on the Board are all factors.
In addition, there may be some leeway to further negotiate unattractive terms if HPL
can articulate the tradeoffs they are willing to make.

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Case 13-3
Dry Clean Depot Limited

Overview

Dry Clean Depot Limited (DCDL) is a private company that has elected to comply with
IFRS. The company is reasonably small, with $7 million in sales, and 40 retail locations.
DCDL has just negotiated a new equipment loan, with covenants that specify a maximum
2-to-1 debt-to-equity ratio. Other covenants require a minimum level of $500,000 in cash,
and restrict dividends to $100,000 per year. These latter covenants require compliance,
but are not affected by accounting policies. The debt-to-equity ratio restriction means that
the company would prefer to maximize equity (earnings) and minimize debt, but ethical
boundaries must be respected.

Issues

1. Effective cost of loan

2. Capitalization of borrowing costs
3. Capital cost of equipment and depreciation
4. Lease arrangement
5. Environmental obligation
6. Revenue recognition
7. Lease terms

Analysis and conclusion

1. Effective cost of loan

DCDL has a choice of using amortized cost of fair value through profit and loss for
the loan. They have decided to use amortized costs since this is the most common
method used for loans.

The effective interest rate for the $2,000,000 loan is determined by looking at the
annual carrying cost ($90,000 per year) and also the $377,000 upfront fee. When both
are factored in, the effective interest rate is 7.2%:

Effective interest rate =

Solve for x in,
$2,000,000 = $377,000 + $90,000 (P/A, x %, 10) + $2,000,000 (P/F, x %, 10)
x = 7.2%

Upfront fees are recorded as a discount and amortized to interest expense (etc.) during
the life of the loan. Since the discount is netted with the loan on the SFP, this
helps modestly reduce debt balances for covenant calculations.

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 2. Capitalization of borrowing costs

The loan is specific to the equipment purchase, and interest must be capitalized during
the acquisition period, which is lengthy. After the acquisition period, interest is an
expense. If there were investment earnings on idle loan cash, for the period between
the time that the loan money is advanced and amounts are paid out to suppliers, such
earnings are netted in the interest capitalization calculation.

General borrowing costs for the portion of the purchase price financed through DCDL
cash flows are also be capitalized, but no imputed costs for equity. The borrowing
cost must be calculated on a weighted average basis.
Further information on each of these issues must be gathered.

Interest to be capitalized:

Loan balance $2,000,000 × 7.2% × 10/12 $120,000

The ten month period consists of six months for production, three months for shipping
plus one month for installation and testing. In terms of time line, the loan is assumed
to be advanced and the equipment immediately ordered. If there is a time lag, the
capitalization period will be longer because capitalization will start when the loan
commences. Interest is capitalized when the loan monies are advanced, in the current
fiscal period.

Additional interest will be capitalized for amounts financed from general borrowings.
This amount is not determinable but information must be gathered to calculate the
adjustment.

Interest capitalization will preserve levels of earnings (equity), making the debt-to-
equity ratio easier to achieve.

3. Capital cost of equipment and depreciation

Many of the costs associated with equipment acquisition will be capitalized, as

follows:

Description Amount
Invoice price $2,450,000
Interest cost (above) 120,000
Interest on general borrowing ??
Shipping 34,000
Duty ($2,450,000 x 20%) 490,000
Installation & testing 38,000
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 $3,132,000 + ??

Equipment is depreciated over its life using an acceptable depreciation method such
as straight-line or declining balance. Policy for this must be set, along with a
determination of the useful life and salvage value, or the declining balance rate. The
equipment should be evaluated to see if components have various life spans; if so,
then depreciation must be stratified to reflect this fact.

4. Lease Arrangement

DCDL must evaluate the need to record a liability for the onerous contract that is
represented by the lease situation in Sudbury. The landlord has been informed that
DCDL will vacate, and a sub-tenant located, with a signed contract for the sub- lease.
This proves positive intent to act.

DCDL has an obligation to pay $27,500 for occupancy costs each year for the next
three years, and has a sub-tenant that is willing to pay at least $5,000 per year.
Therefore, there is an unfunded obligation of $22,500 per year. This may be less if
the extra sub-rent in years 2 and 3, 10% of the sub-tenant sales in excess of
$150,000, can be reliably estimated. However, since DCDL has had negative
experience with this location, and the nature of the sub-tenant operation is
unknown, no amount has been estimated in these calculations. This area must be
explored further.

Since the payments take place over three years, the time value of money must be
estimated to value the liability. Interest expense (accretion) will then be recorded each
year. The interest rate to use should be a borrowing rate for operating activities over
a three-year period. This rate is not known and must be established. A rate of
7%, based on the equipment loan (7.2%) has been used but this rate may not be
comparable because term (10 years) and security are different.

Using the 7% rate, and assuming rent is payable at the beginning of each year:

Liability balance $22,500 × (P/AD, 7 %, 3) (rounded) $63,000

This amount will be recorded as a liability, worsening the debt-to-equity ratio. It is

not avoidable.

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 5. Environmental obligation

DCDL has a contractual liability in eight locations for environmental remediation in

the event of contamination caused by dry cleaning operations, in particular,
contamination caused by perc.

These obligations must be estimated and discounted for the time value of money if
payment is delayed. As for the onerous contract obligation, an interest rate of 7% will
be used as an estimate but a more appropriate interest rate (term and security) must
be estimated.

The liability exists because DCDL stands ready to meet any potential costs. The
major issue is measurement of the liability. If there is no contamination, then the
liability has a zero value and there is no amount recorded. This appears to be the
case for most premises, and regular testing provides comfort that liabilities are
identified on a timely basis.

For one location, however, it appears as though there might be an environmental

issue. Further testing is being done to confirm this, and the outcome of this testing
will determine if remediation, and liability recognition, is needed.

If action is needed, then the cost and the timing of action must be determined. The
cost has been suggested in the $250,000 to $500,000 range. Costs must be further
explored, and an expected value established. If, for example, both of these estimates
were equally likely, then the amount to be accrued would be $375,000. Discounted
for two years at 7%, this is a $325,000 (rounded) liability. This amount is also
capitalized as an asset, amortized over the remaining lease term.

Note that additional liability recognition of a significant amount has negative

implications for the covenant agreement. The annual interest expense on the
provision should also be considered. Some covenant renegotiation might be
considered, or perhaps additional equity financing might be possible.

More importantly, the environmental obligations call the business model into
question, and appropriate pricing and management of operational risks should be
considered and evaluated at a strategic level.

The cost of vacating premises at the end of the lease would also have to be
identified and evaluated for recognition. If DCDL has agreed to move after
environmental cleanup, and this has costs, then the amount must be reflected in the
financial statements. It may well be immaterial.

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 6. Revenue recognition

DCDL sold prepaid dry cleaning services cards (gift cards) this year. When cards
are issued, a contract liability is recognized, and when the cards are used, the
liability is decreased and revenue is recognized. This is appropriate accounting.
Card value of $126,000 ($468,000 - $342,000) is outstanding at year-end, or 27%
of the gross cards issued.

The issue that needs to be examined is how the initial $20 price reduction is treated.
A $120 card costs $100 for the customer, which is in essence a sales discount. The
amount must be relabeled as a sales discount, not an expense, and shown as a contra
account to sales. This is a presentation issue. Revenue should reflect cash value.

This issue can be explained in one of two ways:

1. Services are being sold for a lower price, but this is not below cost (gross profit
is usually 60%); services are still profitable after the reduction granted with the
cards. Valuation of revenue and liability should be at the cash amount received
not the regular price. Therefore, sales of the period should be $285,000
($342,000/1.2), and the liability should be recorded at $105,000
($126,000/1.2). This increases net income (now has $342,000 - $78,000
recorded) and liabilities.

2. Alternatively, valuation can be explained through the discount account. The

discount amount, $78,000 for the cards issued, has been entirely expensed in
the current period. The question is whether this relates to this period, or
whether the $78,000 should be prorated consistent with card use. If it were
prorated, the unused portion would reduce the reported liability.

There is no need to establish a liability for more than the proceeds received.
Accordingly, the sales discount should be recognized as it is used. The discount
should be adjusted to $57,000 ($78,000 x 342/468) and the remaining $21,000
recorded as a contra to the liability account, reducing it to $105,000 ($126,000
- $21,000).

Either of these explanations is acceptable.

DCDL expects that 5 to 10% of the value on the cards will not be used. At the
volumes sold this year, this represents $23,400 to $46,800 of the liability (gross)
outstanding at year-end or $19,500 to $39,000 when deflated to the lower cash
amount. At year–end, this is approximately 20% to 45% of the outstanding liability,
which is very high. The company has a legal obligation in perpetuity for these
amounts, and must stand ready to honor the cards if they are used at any

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 point in the future. The company lacks history to use in determining any unused
percentage. Accordingly, at this stage in the life of this program, it would not be
advisable to decrease the liability for expected unused cards.

In terms of covenant implications, scaling back the liability and increasing

earnings this year are both positive outcomes. It would be preferable to reduce the
liability for unused cards, but if this cannot be measured, it certainly cannot be
manipulated.

7. Lease arrangements

DCDL is a tenant in forty locations. The leases have been described as short-term
rentals, over three to five years As such, they would almost certainly qualify as
operating leases, and no liability for the leases would be recorded. DCDL should
be aware, though, that the IASB is considering a proposal to capitalize all leases
regardless of length of term. This would result in liability recognition for DCDL.
The loan contract just negotiated puts a limit on debt-to-equity over a ten-year
time span, and capitalization might be required within this window. Therefore,
DCDL should negotiate in advance with the lender around the scenario of an
eventual capitalization, perhaps asking that such lease obligations be excluded from
the ratio, or that the ratio be increased to reflect the alternate accounting rules.

Note that if the company decided to early adopt the new lease standard IFRS 16
then the lease would be treated as a finance lease.

Conclusion

Overall, liabilities have been established for environmental issues, onerous

contracts, and potentially for leases. If DCDL is now close to the debt covenant
for debt-to-equity, this will be uncomfortable. It is still the inception of the loan
contract. The company should look at projections for key financial variables and
decide whether the loan covenant is reasonable. If not, re-negotiation or alternate
financing sources must be explored.

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13-14 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Technical Review

Technical Review 13-1

1. T
2. F – if the financial liability was measured in FVTPL the transaction costs would be
expensed
3. T
4. F – amortization of the discount will increase interest expense
5. T

Technical Review 13-2

1. F – there is the option to measure the bonds at fair value every reporting date
2. F – there is option to use either straight line or effective interest method for
amortization
3. F – if the financial liabilities are measured at fair value the transaction costs would be
expensed. If the financial liabilities were measured at amortized cost the transaction costs
would be capitalized to the financial liability
4. F – only interest from specific loans can be capitalized not general loans
5. T

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Technical Review 13-3

Requirement 1

Principal $1,000,000 (P/F, 5%, 10) = $1,000,000 × (0.61391) ..............................$613,910

Interest $40,000 (P/A, 5%, 10) = $40,000 × (7.72173) ....................................... 308,869
$922,779

Cash 922,779
Discount 77,221
Bond Payable 1,000,000

Requirement 2

June 30
Interest Expense 46,139
Amortization of Discount 6,139
Cash 40,000
(922,779 x 5% = $46,139)

Dec 31
Interest Expense 46,446
Amortization of Discount 6,446
Cash 40,000
[(922,779 + 6,139) x 5% = $46,446]

Requirement 3

June 30
Interest Expense 47,722
Amortization of Discount 7,722
Cash 40,000
(77,221 / 10 = 7,722 )

Dec 31
Interest Expense 47,722
Amortization of Discount 7,722
Cash 40,000
(77,221 / 10 = 7,722 )

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13-16 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Technical Review 13-4

Requirement 1

Principal $5,000,000 (P/F, 4%, 20) = $5,000,000 × (0.45639) ..............................2,281,950

Interest $150,000 (P/A, 4%, 20) = $150,000 × (13.59033) ....................................2,038,550
$4,320,500

Requirement 2

Principal $5,000,000 (P/F, 2.5%, 16) = $5,000,000 × (0.67362) ...........................3,368,100

Interest $150,000 (P/A, 2.5%, 16) = $150,000 × (13.05500) .................................1,958,250
$5,326,350

Requirement 3

Present value at 1 August (Requirement 1) ............................................................4,320,500

Present value at 1 February (n=19, below) .............................................................4,343,291
$ 22,791

Issuance proceeds: $4,320,500 + (2/6 of $22,791) .................................................4,328,097

Present value at n=19:

Principal $5,000,000 (P/F, 4%, 19) = $5,000,000 × (0.47464) ..............................2,373,200
Interest $150,000 (P/A, 4%, 19) = $150,000 × (13.13394) ....................................1,970,091
$4,343,291

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Technical Review 13-5

Requirement 1

Principal $6,000,000 (P/F, 3%, 20) = $6,000,000 × (0.55368) ..............................3,322,080

Interest $150,000 (P/A, 3%, 20) = $150,000 × (14.87747) ....................................2,231,621
$5,553,701

Requirement 2

Period Cash interest Interest D or P Closing net

paid expense amortization bond liab.
Op. balance 5,553,701
1 150,000 172,315 22,315 5,576,016
2 150,000 172,315 22,315 5,598,331
3 150,000 172,315 22,315 5,620.646
4 150,000 172,315 22,315 5,642,961

(1) The amount of the discount is $6,000,000 – 5,553,701 = $446,299 / 20 = $22,315

amortized each period.

Technical Review 13-6

Requirement 1

Principal $6,000,000 (P/F, 3%, 20) = $6,000,000 × (0.55368) ..............................3,322,080

Interest $150,000 (P/A, 3%, 20) = $150,000 × (14.87747) ....................................2,231,621
$5,553,701

Requirement 2

Period Cash interest Interest D or P Closing net

paid expense amortization bond liab.
(3%)
Op. balance 5,553,701
1 150,000 166,611 16,611 5,570,312
2 150,000 167,109 17,109 5,587,421
3 150,000 167,622 17,622 5,605,043
4 150,000 168,151 18,151 5,623,194

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13-18 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Technical Review 13-7

Requirement 1

Power receives $9,360,000 ($10,000,000 less $640,000)

Requirement 2

The IRR of the payment stream is 3%, compounded semi-annually, or 6% per year.

Solve for i in:

$10,000,000 = $640,000 + [$225,000 (P/A, i, 10)] + [$10,000,000 (P/F, i, 10)]

Requirement 3

Period Cash interest Interest D or P Closing net

paid expense amortization bond liab.
(3%)
Op. balance 9,360,000
1 225,000 280,800 55,800 9,415,800
2 225,000 282,474 57,474 9,473,274
3 225,000 284,198 59,198 9,532,472
4 225,000 285,974 60,974 9,593,446

Technical Review 13-8

Borrowing rate = $174,000/ $2,900,000 = 6%

Payment Calculation Capitalizable

Early June $1,200,000 × 4/12 × 6% $ 24,000

(June to September)
October $126,000 × 0
Capitalization period ends at the
end of September because goods
available for sale.
$24,000

To capitalize borrowing costs:

Inventory 24,000
Interest expense 24,000
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13-19 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Technical Review 13-9

To update interest expense and amortization:

Interest expense............................................................................... 22,533
Premium on bonds payable ............................................................ 800
Cash ($10,000,000 × 20% × 7% × 2/12) ............................... 23,333

To record the retirement:

Bonds payable ($10,000,000 x 20%) ..............................................2,000,000
Premium on bonds payable ($84,000 x 20%) less $800 ................. 16,000
Loss, retirement of debt .................................................................. 184,000
Cash......................................................................................... 2,200,000

Technical Review 13-10

The note would be recorded at $325,000 x $1.01 = $328,250.

Year one $325,000 x ($1.01 - $1.03) = $6,500 exchange loss

Year two $325,000 x ($1.03 - $0.98) = $16,250 exchange gain

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Assignments

Assignment 13-1

Logical circumstances for:

Operating line of credit Need for short-term financing; Accounts receivable

and/or inventory available for security.
Commercial paper Large corporation with good credit rating; financial
intermediary available.
Term loan Medium-term loan from a financial institution, with
tangible capital assets available for security.
Commercial mortgage Loan from a financial institution secured against
land and buildings; term is often 5 years but
amortization period for blended payments is longer.
Long-term bond payable Need for long-term financing.
Equity financing No concern loss of control need for financing but
no requirement for annual cash flows for interest.

Assignment 13-2

Financing source
Case A The company’s primary assets are land Commercial mortgage;
and buildings typical security for a mortgage
Case B The company is a large public company Long-term bonds payable;
with significant tangible assets and a tangible assets are possible
need for millions of dollars in long-term security and company size and
financing. capital need match the bond
market
Case C The company’s primary assets are Equity financing;
intangible and earnings are erratic No tangible assets for security for
a loan and risk high because of
erratic earnings

Case D The company requires short-term Operating line of credit;

financing and has sizeable inventory and typical security for an operating
account receivable balances line of credit

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13-21 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-3

Financing source
Case A The company is a large public company Commercial paper;
with significant tangible assets, an Circumstances qualify for
excellent credit rating, and a need for commercial paper as long as an
short-term loans at low cost. intermediary exists.
Operating line of credit is another
alternative
Case B The company has significant tangible Equity financing;
assets that are all pledged as security for No tangible assets for security for a
other loans, and the industry sector is loan and risk high because of
very risky. industry

Case C The company’s primary assets are Term loan;

machinery and equipment. typical security for a term loan
Case D The company’s primary assets are Operating line of credit;
accounts receivable. typical security for an operating
line of credit

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13-22 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-4

Requirement 1

Principal: $4,000,000 × (P/F, 2.5%, 16) = $4,000,000 × 0.67362 = $2,694,480

Interest: ($4,000,000 × 2.25%) × (P/A, 2.5%, 16) = $90,000 × 13.055 = 1,174,950
Issue proceeds at 30 April 20X0 $3,869,430

Requirement 2

Principal: $4,000,000 × (P/F, 2%, 11) = $4,000,000 × 0.80426 = $3,217,040

Interest: ($4,000,000 × 2.25%) × (P/A, 2%, 11) = $90,000 × 9.78685 = 880,817
Issue proceeds at 30 October 20X2 $4,097,857

Requirement 3

Principal: $4,000,000 × (P/F, 4%, 14) = $4,000,000 × 0.57748 = $2,309,920

Interest: ($4,000,000 × 2.25%) × (P/A, 4%, 14) = $90,000 × 10.56312 = 950,681
Issue proceeds at 30 April 20X1 $3,260,601

Requirement 4

At 30 October 20X5, there are five interest periods remaining:

a. Book value

Principal: $4,000,000 × (P/F, 2.5%, 5) = $4,000,000 × 0.88385 $3,535,400

Interest: ($4,000,000 × 2.25%) × (P/A, 2.5%, 5) = $90,000 × 4.64583 = 418,125
$3,953,525

b. Fair value

Principal: $4,000,000 × (P/F, 5%, 5) = $4,000,000 × 0.78353 $3,134,120

Interest: ($4,000,000 × 2.25%) × (P/A, 5%, 5) = $90,000 × 4.32948 = 389,653
$3,523,773

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13-23 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-5

Requirement 1

Principal: $20,000,000 × (P/F, 3%, 20) =

$20,000,000 × 0.55368 = $11,073,600
Interest: ($20,000,000 × 2.75%) × (P/A, 3%, 20) =
$550,000 × 14.87747 = 8,182.609
Issue proceeds at 1 June 20X5 $19,256,209

Interest expense:
$19,256,209 × 3% = $577,686
Interest paid: $550,000

Requirement 2

Principal: $20,000,000 × (P/F, 4%, 16) =

$20,000,000 × 0.53391 = $10,678,200
Interest: ($20,000,000 × 2.75%) × (P/A, 4%, 16) =
$550,000 × 11.65230 = 6,408,765
Issue proceeds at 1 June 20X7 $17,086,965

Interest expense:
$17,086,965 × 4% = $683,479
Interest paid: $550,000

Requirement 3

Principal: $20,000,000 × (P/F, 2%, 11) =

$20,000,000 × 0.80426 = $16,085,200
Interest: ($20,000,000 × 2.75%) × (P/A, 2%, 11) =
$550,000 × 9.78685 = 5,382,768
Issue proceeds at 30 November 20X9 $21,467,968

Interest expense:
$21,467,968 × 4% = $ 429,359
Interest paid: $ 550,000

Requirement 4

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13-24 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
In all cases, interest expense is not cash paid. Interest expense is dictated by the yield rate,
not the nominal rate. Interest paid will always remain consistent at the nominal rate.

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13-25 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-6

Requirement 1
Principal $10,000,000 x (P/F 3%, 20) (.55368) = $5,536,800
Interest $325,000 x (PVA 3%, 20) (14.87747) = 4,835,178
$10,371,978
Requirement 2

Period Cash interest Interest D or P Closing net

paid expense amortization bond liab.
Op. balance 10,371,978
1 325,000 311,159 13,841 10,358,137
2 325,000 310,744 14,256 10,343,881
3 325,000 310,316 14,684 10,329,197
4 325,000 309,876 15,124 10,314,073

Requirement 3

1 October 20x4
Cash .............................................................................10,371,978
Premium on bonds payable.................................................... 371,978
Bonds payable........................................................................ 10,000,000

31 December 20x4
Interest expense ($311,159 x 3/6).................................................. 155,580
Premium on bonds payable ($13,841 × 3/6).................................. 6,920
Interest payable ($325,000 × 3/6) .......................................... 162,500

31 March 20x5
Interest expense ($311,159 x 3/6).................................................. 155,579
Interest payable .............................................................................. 162,500
Premium on bonds payable ($13,841 × 3/6).................................. 6,921
Cash ....................................................................................... 325,000

30 September 20x5
Interest expense ............................................................................. 310,744
Premium on bonds payable ........................................................... 14,256
Cash ....................................................................................... 325,000

31 December 20x5
Interest expense ($310,316 x 3/6).................................................. 155,158
Premium on bonds payable ($14,684 × 3/6).................................. 7,342
Interest payable ($325,000 × 3/6) .......................................... 162,500

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13-26 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-7 (WEB)

Requirement 1

Bond proceeds:
P = $3,000,000 × (P/F, 4%,20) + ($3,000,000 × 5%) × (P/A, 4%,20)
= ($3,000,000 × 0.45639) + ($150,000 × 13.59033)
= $1,369,170 + $2,038,550
= $3,407,720

Requirement 2

30 September 20x1:
Cash ........................................................................ 3,407,720
Bonds payable ................................................ 3,000,000
Premium on bonds ......................................... 407,720

31 March 20x2:
Interest expense ...................................................... 136,309
Premium on bonds.................................................. 13,691
Cash ................................................................ 150,000
[interest expense = 4% of $3,407,720]

30 September 20x2:
Interest expense ...................................................... 135,761
Premium on bonds.................................................. 14,239
Cash ................................................................ 150,000
[interest expense = 4% of ($3,407,720 – $13,691) = .04($3,394,029)]

31 March 20x3:
Interest expense ...................................................... 135,192
Premium on bonds.................................................. 14,808
Cash ................................................................ 150,000
[interest expense = .04($3,394,029 – $14,239) = .04($3,379,790)]

30 September 20x3:
Interest expense ...................................................... 134,599
Premium on bonds.................................................. 15,401
Cash ................................................................ 150,000
[interest expense = .04($3,379,790 – $14,808) = .04($3,364,982)]

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13-26 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Requirement 3

The unamortized premium on 1 October 20x7, using the effective interest method, is the
present value of the remaining cash flows at that date, less the principal amount of the
bonds at 1 October 20x7, four years before maturity:

Unamortized premium = [$3,000,000(P/F, 4%, 8) + $150,000(P/A, 4%, 8)] – $3,000,000

= [$3,000,000(.73069) + $150,000(6.73274)] – $3,000,000
= ($2,192,070 + $1,009,911) – $3,000,000
= $3,201,981 – $3,000,000
= $201,981

Requirement 4

Premium amortization for next 6 months:

Using the answer to requirement 4:

The present value of the bonds at 1 October 20x7 is $3,201,981.
Interest expense for the next six months is 4% of the PV, or $128,080.
Premium amortization is the difference between the expense of $128,080 and the
payment of $150,000, or $21,920.

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13-27 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
Assignment 13-8

Requirement 1

Price of bond:
P $4,000,000 (P/F, 2%, 7) = $4,000,000 × (.87056)....................$3,482,240
I $100,000 (P/A, 2%, 7) = $100,000 × (6.47199) ....................... 647,199
$4,129,439

Requirement 2

Interest Interest Premium Unamortized Net bond

Date Payment Expense Amortization Premium Liability

Opening $129,439 $4,129,439

1 $100,000 $82,589 $ 17,411 112,028 4,112,028
2 100,000 82,241 17,759 94,269 4,094,269
3 100,000 81,885 18,115 76,154 4,076,154
4 100,000 81,523 18,477 57,677 4,057,677
5 100,000 81,154 18,846 38,831 4,038,831
6 100,000 80,777 19,223 19,608 4,019,608
7 100,000 80,392 19,608 0 4,000,000

Requirement 3

Cash ........................................................................................ 4,129,439

Premium on bonds payable ................................................ 129,439
Bonds payable ..................................................................... 4,000,000

31 December 20x9 (adjusting entry):

Interest expense (4/6)................................................................... 55,059
Premium on bonds payable ......................................................... 11,607
Accrued interest payable ................................................... 66,666

28 February 20X10
Accrued interest payable ........................................................... 66,666
Interest expense (2/6)................................................................... 27,530
Premium on bonds payable (2/6) .............................................. 5,804
Cash ................................................................................ 100,000

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13-28 Solutions Manual to accompany Intermediate Accounting, Volume 2, 7th edition
31 August 20x10
Interest expense .......................................................................... 82,241
Premium on bonds payable ........................................................ 17,759
Cash ................................................................................... 100,000

31 December 20x10 (adjusting entry):

Interest expense (4/6)................................................................... 54,590
Premium on bonds payable ......................................................... 12,076
Accrued interest payable ................................................... 66,666

Requirement 4

20x9
Interest expense $55,059

20x10
Interest expense ($27,530 + $82,241 + $54,590) $164,361

Requirement 5

20x9
Bonds payable, 5%, effective rate 4%, due 28 February 20X13 $4,000,000
Premium on bond payable ($129,439 – $11,607) 117,832
$4,117,832
20x10
Bonds payable, 5%, effective rate 4%, due 28 February 20X13 $4,000,000
Premium on bond payable ($117,832 - $5,804 - $17,759 - $12,076) 82,193
$4,082,193

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Exploring the Variety of Random
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belonged to that other, he emptied the bitter cup to the dregs, and
said 'yes' because he imagined that she had already said it.
Elizabeth, I stood on the threshold of the pavilion to-day in a state of
utter despair. You do not know what it is, when a merchant heaps all
his treasure, every jewel that he possesses, in a single ship, and
sees it sink before his eyes. Shall I try to tell you what I felt when
you so decidedly rejected the rank which you might have claimed,
and so made an alliance with Hollfeld impossible? Shall I tell you
that my sister's condition, and consideration for you yourself, alone
prevented me from chastising that scoundrel upon the spot? He has
already left Lindhof, and will never cross your path again. Will you
forget the insult that you received in my house to-day?"
He had taken her hands in his, and held them pressed close to
his breast. Without withdrawing them she assented to his question
with trembling lips.
"And shall we not forget everything, my darling little Gold Elsie,
that has occurred between the beginning and the conclusion of the
birthday wish? My golden darling, the delight of my eyes, my own
Elizabeth Ferber stands again before me, and will repeat after me
what I say, will she not? The last sentence which was so cruelly
interrupted—tell me what it was."
"Here is my hand as the pledge of an unutterable bliss," faltered
Elizabeth.
"In life, in death, and for all eternity, I will be your own."
But she opened her lips in vain to repeat after him the words
which he uttered so solemnly, with the most profound emotion. She
burst into tears and threw her arms around the neck of her lover,
who clasped her to his heart.
 "This divine dream must not fade," he said with a sigh, as
Elizabeth gently extricated herself from his embrace. "Leave me your
hand at least, Elizabeth, I must learn to believe in my bliss. If you
leave me now, I shall be crushed by doubt again to-night. You are
thoroughly conscious that you are irrevocably mine? Do you know
that you must leave father and mother, and the dear home upon the
mountain, for my sake?"
"I know it, and will do so gladly, Rudolph," she said smiling, but
firm.
"God bless you, my darling, for those words! But you must know
the depths of my doubt. Is it not pity for my boundless love that
induces you to yield your consent to my suit?"
"No, Rudolph, it is love,—a love which first awoke in my heart,—
does not this sound strangely,—when I saw in your angry eyes, and
heard in the tones of your voice, how you detested cruelty and
injustice! And since that moment it has never left me; on the
contrary, it has increased and grown stronger, in spite of all my
efforts to destroy it, notwithstanding all the harsh words that have
so often wounded it sorely."
"Who spoke such words?"
"You, yourself; you were harsh and unkind to me."
"Oh, child, those were the outbreaks of insane jealousy! I have
struggled for and exercised self-control all my life long, but I could
not conceal how I was tortured then. And would you, on that
account, have closed upon me the heaven that is opening before
me?"
"Not on that account,—for one kind look from you made me
happy again; but another obstinate opponent entered the lists,—my
reason. It had grown well aware of everything that report declared
concerning your incredible aristocratic arrogance, and, at every wild
throb of my heart, dinned into my ears your reasons for refusing the
alliance which the prince proposed to you."
"Ah! those sixteen quarterings!" cried Herr von Walde, smiling,
"But see, my little Gold Elsie, what a Nemesis that was!" he
continued more gravely. "To avoid annoyance, I seized upon the first
means at hand, and, as I now know, it almost cost me the happiness
of my life. I like the Prince of L——, but any residence at his court
was rendered, for a time, utterly odious to me, by the matrimonial
alliances proposed for me, principally by the Princess Catharine. She
had taken it into her head that I must marry one of the ladies of her
court. No one could believe that the girl was entirely indifferent to
me, for she passed for a brilliant beauty, and had broken many a
heart. All that I could say was of no avail; they continued to plot and
intrigue, and so one day I cut the whole matter short by declaring to
her Highness that her plan for me would cost me one of my estates,
since, as is true, by my uncle's will it was devised to the State if I
should marry a wife who could not show sixteen quarterings in her
escutcheon. This declaration put an end to my torment; no such
person was to be found in the length and breadth of the little
kingdom, and all thought it natural that I should wish to retain my
estate."
"And will you suffer this loss for my sake?" cried Elizabeth, in
surprise.
"It is no loss, Elizabeth; it is an exchange,—an exchange by
which I gain a priceless treasure,—the happiness of an entire
existence."
 A torch glimmered through the thicket.
"Halt! this way!" cried Herr von Walde.
In a few moments one of the servants appeared, and was
ordered to hasten as quickly as possible to Gnadeck and announce
Fräulein Ferber's safety.
The servant hurried away.
"I have been very selfish, Elizabeth," said Herr von Walde,
putting her hand within his arm, and no longer loitering. "I knew
that your family was most anxious about you; that your father and
uncle were ranging the forest in search of you, while my people, and
many of the Lindhof peasants, were traversing the country in all
directions upon the same errand, and yet I forgot everything when I
found you."
"My poor father and mother!" sighed Elizabeth, not without a
slight twinge of conscience; the whole world had ceased to exist for
her when he appeared.
"Friedrich runs quickly," von Walde said, soothingly; "he will
reach the summit of the mountain long before us, and tell them you
are safe."
They entered the park and passed by the castle. It lay in
darkness and silence. Only from Helena's chamber window gleamed
a faint light.
"There is a life-and-death struggle going on there," murmured
Herr von Walde, looking up. "She loved that wretch devotedly; how
fearful her awakening must be!"
"Go and comfort her," begged Elizabeth.
"Comfort her? At such a moment? My child, who could have
come to me with comfort when I thought I had lost you? Helene
shut herself in her room when I ordered Herr von Hollfeld's horse to
be brought to the door; her maid is near her. A long time must
elapse before she wishes to see me; when we have been grossly
deceived we do not immediately turn to those who warned us of the
deceit. Besides, I will not enter my house again until I am sure that
your parents will not snatch you from me."
The path branched aside to the well-known bank in the forest.
"Do you remember?" asked Elizabeth, smiling, as she pointed to
it.
"Yes, yes. There you told me so bravely of your determination to
go out into the world as a governess, and I took the liberty of
declaring to myself that I never would permit it. I had to exert all my
self-control to prevent myself from then and there clasping my little
bird in my arms and pressing its golden head, filled with such bold
resolve, to my breast. And there I drew from you the unconscious
naive confession that your parents still held the first place in your
heart. But you adopted a cold, repellant demeanour, as soon as I
attempted to be confidential."
"It was shyness,—and I am not yet quite sure that to-morrow,
when I see your stern face by daylight, I shall not fall into the same
embarrassment."
"It will never be stern again, my child; joy has touched it with
its gentle finger."
Soon afterwards, the old beeches which look in at the windows
of the Ferber's dwelling-room saw a strange sight. A man of fine
presence, his face pale with profound emotion, conducted the
daughter to her parents, and then asked them to give her back to
him as his future wife,—his other self. The old beeches saw him take
his young love in his arms, and receive the blessing of her agitated
parents. They saw the mother's face, smiling through tears, raised
gratefully to Heaven, and little Ernst shaking the canary's cage, that
he might awaken that sleepy songster and announce to him, with
great solemnity, that Elsie was betrothed.
 CHAPTER XX.

While happiness was reigning in the home upon old Gnadeck, a sad
event occurred in the valley.
Two peasants from Lindhof, who, provided with torches, had
been looking for Elizabeth, heard, as they were proceeding from
their village to the forest, a loud growling at a little distance,—it
sounded like an angry dog. Not far from them lay stretched across
the road a human form, while a large dog lying beside it, as if to
defend it, had placed both his forepaws upon its breast. The animal
became infuriated at the approach of the men, and, gnashing its
teeth, threatened to fly at them. They were afraid, and ran back to
the village, where they met a party bearing torches, and among
them the forester, who had just heard from Herr von Walde's servant
of Elizabeth's safety.
Instantly all hastened to the spot which the frightened peasants
described. This time the dog did not growl. He whined, and crept to
the forester's feet; it was Wolf, his watch-dog, and there lay Bertha,
apparently lifeless. She was bleeding profusely from a wound in her
head, and her face was as pale as death.
The forester did not speak, he shunned the sympathetic glances
of the by-standers; anger and pain strove for the mastery in his
features. He raised Bertha from the ground, and carried her into the
first house in the village; it was the poor weaver's. Then he sent a
messenger for Sabina. Fortunately, the Waldheim physician was with
one of his patients in the village. He was sent for, and soon brought
the poor girl to herself. She recognized him, and asked for water. Her
wound was not dangerous, but the physician shook his head and
looked meaningly at the forester, who was anxiously watching him.
The doctor was a blunt man, with rather rude manners. He
suddenly approached the forester, and said a few words to him in a
slight undertone. The old man staggered back as though from a
mortal blow, stared absently at the doctor without replying a word,—
and then left the house without looking at the sick girl.
"Uncle, uncle, forgive me!" she cried after him in heart-breaking
tones, but he had already vanished into the dark night.
And now Sabina made her appearance in the doorway. A maid
followed her, bearing a huge bundle of linen upon her head, and a
basket upon her arm, containing bandages, provisions, and all
manner of necessary articles.
"Gracious Powers! what have you been doing with yourself,
Bertha?" cried the old woman with tears in her eyes, as she saw the
pale face, and the bandaged head lying upon the pillow. "And to-
day, too, when I thought you went out looking so much better,—you
had such beautiful red cheeks!"
The girl buried her face in the bedclothes, and began to sob
convulsively.
The physician told Sabina what was to be done, and strictly
forbade the invalid to converse or even to speak.
"Must I be silent?" cried Bertha, raising herself in bed. "Ah!
silence may be easy for such an old man, whose blood runs cool and
calm in his veins. But I must speak, Sabina, and if it kills me,—so
much the better!"
 She drew the old housekeeper towards her upon the bed, and,
weeping bitterly, confessed all to her.
She had had a love affair with Hollfeld, who had promised to
marry her, and had induced her to swear solemnly that she would
keep silent concerning their relations to each other, and not claim
her rights until he should authorize her to do so; for, as he told her,
he must first influence his mother and his relatives at Lindhof to
accede to his wishes. The unthinking girl promised all that he asked,
—and in addition vowed solemnly that no human being should hear
one word from her lips until she could proclaim her proud secret to
the world. The meetings of the pair usually took place in the
convent-tower or in the pavilion in the park. No one discovered
them. The baroness' suspicions were aroused by some slight
circumstance,—she fell into a violent rage, and forbade Bertha ever
to show her face at Lindhof Castle.
Still Bertha's lofty hopes were unshaken, for Hollfeld consoled
her, and referred to the future. But then came Elizabeth Ferber, and
he was an altered man from that moment. He avoided Bertha, and
when she compelled him by threats to an interview, he treated her
with a coldness and contempt that excited the girl's passionate
nature to frenzy.
When at last she became convinced that she had to do with a
man utterly devoid of honour, the whole horror of her situation was
laid bare before her. She fell into a state of the wildest despair, and
then began her nightly escapades. Sleep scarcely visited her eyes,
and she grew more composed only when she could shriek out her
agony and woe in the lonely forest.
 At last came the end to the tragedy,—the same end that has
befallen such tragedies hundreds of times before, and that will
continue to befall them,—for the warning example convinces the
understanding but never touches an unsuspecting, loving heart.
Hollfeld offered the poor girl a sum of money if she would relinquish
her claims and leave that part of the country. He pretended that his
mother and his Lindhof relatives forced him to marry the newly-
made Fräulein von Gnadewitz. Bertha denounced him as an
unprincipled liar, and rushed from his presence. In a frenzy of rage
she presented herself before his mother and told her all.
Thus far Bertha continued her sad tale connectedly, only
interrupted by her violent gestures, sobs, and tears. She paused for
a moment, and an expression of inextinguishable hatred distorted
her countenance.
"That horrible woman," she cried at last, gasping for breath,
"has the Bible always upon her lips. She knits and sews night and
day for missionaries, who are to carry the word of God to the
heathen, that they may be converted; but they cannot in their
ignorance be more inhuman and cruel than this Christian in her
pride. She wishes to root out idol-worship, and sets up herself for an
idol, surrounding herself by a crowd of fawning, flattering hypocrites,
who declare that she is one of the elect,—not as other people are.
Woe to the upright, honest man who refuses to consider her as
such,—his crime is blasphemy! She thrust me from her doors, and
threatened to have the dogs hunt me from the park, if I ever
showed my face there again. From that time I do not know what
became of me," she said, sinking back exhausted among the pillows,
and pressing her hands upon her aching forehead. "I only know that
I awaked and saw the doctor's face bending over me. He told my
uncle of my disgrace,—I heard him. What will become of me!"
Sabina had listened to this confession with horror and grief. She
had always advocated the strictest purity and decorum, and had
been, as Bertha well knew, a stern and inflexible judge in such
unhappy cases as that of the wretched girl. But her heart was full of
love and pity. She looked down upon the crushed sinner before her
with tears of compassion, and soothed the weary head upon her
kind old breast. She was rewarded by seeing the poor girl fall asleep
in her arms, like a child worn out with weeping.
Soon nothing was heard in the little room but the quiet
breathing of the sick girl and the ticking of the clock. Sabina put on
her spectacles, drew an old worn copy of the New Testament from
her basket, and watched faithfully by the bedside until the bright
dawn looked in at the windows.
Bertha did not die, as she had hoped to do in consequence of
her agitating confession. On the contrary, she recovered very quickly,
nursed and tended by Sabina and Frau Ferber. There was no return
of her insanity. The wound in her head, which had been caused by a
fall upon a sharp stone, had produced a most beneficial result in the
copious loss of blood which had ensued.
The forester was beside himself at the disgrace which Bertha
had brought beneath his honest roof. For some days he would not
even listen to his brother's calm, soothing words. After Sabina had
communicated to him Bertha's confession, he rode to Odenberg to
call "the worthless scoundrel to account;" but the servants there
informed him, shrugging their shoulders, that their master had
started upon a journey; they could not tell whither, or when he
would return. Herr von Walde's search for him was also without
result.
Bertha herself declared that she would never again hear of her
betrayer, whom she now regarded with a hate as fervent as had
been her love. A few weeks after her recovery she left the weaver's
hut,—she never again entered the Lodge,—to go to America. But
she did not go alone. One of her uncle's assistants, a fine young
fellow, begged for his dismissal, because he had always loved Bertha
in silence, and could not find it in his heart to let her go alone into
the wide world. She had promised to be his. They were to be
married in Bremen, and sail thence for the New World, where he
would lead a farmer's life. Herr von Walde provided the pair with a
considerable sum of money; and, at Frau Ferber's and Elizabeth's
request, the forester silently consented that Sabina should rob the
overflowing store of linen that his deceased wife had accumulated,
to furnish the household of the emigrants.

* * * * *

Upon a gloomy autumn day a well-packed travelling carriage left

Castle Lindhof and slowly rolled towards L——. Her haughty
arrogance all vanished, the baroness sat huddled together in one
corner of it. Her brilliant part at Lindhof was played; she was
reluctantly returning to her small rooms and reduced circumstances.
"Mamma," said Bella, in her shrill, childish accents, as she
opened and shut the carriage window and drummed against the seat
with her feet, "does the castle belong now to Elizabeth Ferber? Will
she drive in our beautiful carriage with the white damask cushions?
Can she go into your room whenever she pleases and sit in the
embroidered arm-chairs? Old Lorenz says that she will be the
mistress there now, and that all her orders must be obeyed."
"Child, do not torment me so with your chatter," groaned the
baroness, burying her face in her pocket-handkerchief.
"It is very unkind of Uncle Rudolph to send us away," the child
continued, without heeding what her mother said. "You know we
have no silver dishes to eat from in B——, have we, mamma? Shall
we dine at a restaurant, mamma? and will you dress your own hair
while Caroline washes and irons? Why——"
"Silence!" her mother interrupted the flood of speech that so
tormented her.
Bella cowered terrified in a corner, and did not look up until the
carriage was rolling over the stone pavement of L——. The baroness
cast a hasty glance at the Princely castle, then drew her veil over her
face and burst into tears.
In consequence of Bertha's confession there had been a stormy
interview between Herr von Walde and the baroness, which had
ended in the departure of the latter. Helene repulsed her with
aversion when she appealed to her, and she was forced to enter the
travelling carriage, which appeared punctually before the castle at
the hour appointed by its master. There was one consoling drop in
her cup of misfortune,—Herr von Walde had provided the means for
Bella's education, upon condition that it should be more sensibly
conducted than heretofore.
Almost at the same hour in which the Baroness Lessen was
leaving Lindhof forever, the Countess von Falkenberg presented
herself in the boudoir of the princess, who had returned with her
husband a few days before from the baths.
 The countess made as profound an obeisance as her uncertain
limbs would permit, but showed a degree of haste that she would
have stigmatized in another as contrary to all rules of etiquette. She
held an open letter in her hand, which had been somewhat crushed
by her trembling fingers.
"I am most unhappy," she began in an unnatural tone of voice,
"to be obliged to impart to your highnesses a most scandalous piece
of news. Oh, mon Dieu, who would have thought it! Well, if even in
our own sphere all sense of shame, all dignified self-consciousness,
is at an end,—if every one is to heed the dictates of low and vulgar
impulses,—no wonder that the halo surrounding us is dimmed, and
the mob ventures to attack the throne itself!"
"Calm yourself, my dear Falkenberg," said the prince, who was
present, with evident amusement. "Your preface is somewhat after
the magnificent style of a Cassandra. But as yet I see no signs of
earthquake; and to my great satisfaction I observe,"—and he
glanced out of the window at the quiet market-square with a smile,
—"that my faithful subjects are quite composed. What have you to
tell us?"
She looked up surprised,—his sarcastic tone made her falter.
"Oh, if your highness only knew!" she cried at last. "That man,
upon whose pride of birth I so relied, Herr von Walde, informs me
that he is betrothed. And to whom? to whom?"
"To Fräulein Ferber, the niece of my brave, old forester," the
prince, smiling, replied. "Yes, yes, I have heard something of this;
Walde knows what he is about, I see. The little girl is a miracle of
beauty and loveliness they say. Well, I hope he will not keep us
waiting long to make her acquaintance, but will present her to us
soon."
"Your highness," cried the paralyzed countess, "she is the
daughter of your highness' forester's clerk!"
"Yes, yes, my good Falkenberg," chimed in the princess, "we
know that. But be calm; she is I assure you of noble rank."
"Will your highness graciously permit me," rejoined the old lady,
her face crimson, as she pointed to the crumpled letter, "here it
stands in black and white,—his betrothal with a person of low birth,
—here is the name, Ferber, and no other, and just so it will be
written upon von Walde's genealogical tree forever. It actually seems
as if the man paraded it with a sort of ostentation. The inconceivable
indifference of these people in refusing to assume the name of von
Gnadewitz shows plainly enough that they have nothing in common
with that aristocratic family. Their noble blood has utterly
degenerated in the course of years, and, according to my notions of
nobility, the girl is and always will be of low birth. I sincerely pity
poor Hollfeld, who is, as your highness knows, of stainless descent;
by this misalliance he will lose at least half a million,—and the poor
Lessen, too, from whom I have just had a few sad lines,—she leaves
Lindhof to-day, of course to escape from such scandalous
proceedings."
"Those are matters affecting your own personal feeling, and of
course I say nothing with regard to them," rejoined the prince, not
without severity. "But I herewith request you to announce to the
princess and myself the fact, as soon as Herr von Walde wishes to
present his bride to us."
 In the next room, the door of which was open, Cornelie was
merrily turning upon her heels and snapping her fingers.
"Aha! and that was why Sir Bruin wished to escape the tongues
of certain eloquent ladies!" she cried, with a stifled laugh. "Cornelie,
where was your usual penetration with regard to the masculine
heart? Oh, the thing delights me for old Falkenberg's sake," she said,
in a whisper, to another young lady who sat at the window
embroidering. "Now for at least two weeks we shall have the
pleasure of seeing how the loyal creature will look daggers at their
highnesses whenever their backs are turned, while all the honey of
the promised land will overflow her withered lips as soon as the sun
of their royal smile shines upon her. I could wish that every man
whom we know would follow Herr von Walde's silly example!"
"Good Heavens! Cornelie, are you insane?" cried her companion
at the window, dropping her needle from her fingers.
At the same time that every drop of blood in the Falkenberg's
aristocratic veins was so outraged, Doctor Fels returned to his home,
and went to the nursery, where his wife was bathing her baby and
superintending the knitting fingers of her two little daughters.
"Rejoice with me, dear love!" he cried, with sparkling eyes, as
he stood upon the threshold of the door. "Lindhof will have a
mistress, and such a mistress! Gold Elsie, our beautiful Gold Elsie!
Do you hear, my darling? Now the sun will shine brightly there. The
healthy atmosphere has conquered, and the evil spirit that actually
dropped mildew upon poor human souls has fled. I have just seen it
drive past in Herr von Walde's travelling carriage. The
announcement of the betrothal has fallen upon our worthy town like
a bomb-shell. I tell you it is wonderful to see the long, incredulous
faces! But the news has not surprised me at all. I have known what
must happen ever since Linke's murderous attempt. Since I drove
that evening to Lindhof by Herr von Walde's side, to see whether the
excitement had produced no ill effects upon the brave child, I have
known well that his hour had struck, that he had a heart indeed, a
heart full of fervent, passionate love."

* * * * *

Let us pass over a space of two years, and once more enter the old
Gnadeck ruins. We shall ascend the mountain by a broad well-kept
road, leading to the castle gate, which has exchanged its rusty bolts
and bars for more convenient fastenings.
We remember with a shiver the cold, damp court-yard behind
this gate, shut in by gloomy colonnades on three sides, while the
crumbling buildings threatened to bury us beneath their ruins. We
remember the lonely basin in the centre, that, surrounded by the
lions of stone, has waited in vain during so many years for the silver
stream that should fill it.
Remembering all this, we ring the bell. At its clear sound, a
fresh, trim maiden opens the massive gate, and invites us to enter.
But we start back almost dazzled, for from the open gate what a
flood of light and colour greets us! The ruins have vanished, the high
wall that surrounded them alone remains, and we are for the first
time aware how extensive is the space which it encloses.
We do not tread upon the echoing pavement of a courtyard, a
smooth gravel-walk is beneath our feet; before us stretches a level,
well-kept lawn. In its centre stands the granite basin, and from the
threatening jaws of the lions are pouring four powerful streams of
water. The chestnuts still remain the faithful guardians of the
fountain, but since their boughs have been bathed in heaven's air
and light they have grown strong and young again, and are now
covered with a wealth of fan-like blossoms. We wind among the
gravel paths that intersect the lawn, delight our eyes with the groups
of shrubbery, still very young, that are so tastefully scattered here
and there, and with the gay beds of carefully tended flowers.
Before us lies the home. Its four walls are free now to the air
and light, and have put on a fresh bright garment; but its front is far
more stately than it used to be. New windows are seen on every
side. Ferber has had four rooms added to it; for when the forester
retires to private life, he and Sabina are to live there also. In the
family dwelling-room,—from whose two high windows can now be
seen the same view formerly seen only from Elizabeth's room above,
—Herr von Walde has had the trees thinned so that her parents
might always have the home of their darling before their eyes,—
stands the young Frau von Walde. She has been kept in the house
for several weeks, and her first expedition has been to carry her
first-born to her parents' home. There he lies in her arms. Miss
Mertens, or rather the happily married Frau Reinhard, has just
removed the veil from the little thing. The minute, plump, red face
shows, in the eyes of the mother, an unmistakable resemblance to
Herr von Walde. Ernst is laughing loudly at the vague movements of
the fat little fists, which are stretching out in all directions. But the
forester stands with his own powerful hands behind him, and an
expression of great anxiety, as if he feared that if he moved he
might do the frail atom an injury. He is no less delighted with his
grand-nephew than are Elizabeth's parents with their grandchild. He
has outlived his distress concerning Bertha, and basks in Elizabeth's
happiness, which was a great surprise to him at first, and which he
maintained he was obliged to become accustomed to anew every
morning. Not, indeed, that he thought such good fortune one whit
too great for his darling,—he would have thought the richest of
earthly crowns well placed upon Elizabeth's head; but it was so
strange to him to see his sunny Gold Elsie by the side of her grave,
thoughtful husband.
Elizabeth is happy in the fullest sense of the word. Her husband
adores her, and his words have proved true,—the expression of stern
melancholy has faded forever from his brow.
Just now the young wife is looking tenderly at the little creature
in her arms, and then down into the valley, whence Herr von Walde
will soon appear to conduct her to her home. Her glance grows sad
for a moment, and tears fill her eyes, as they rest upon a lofty gilded
cross, glimmering among the trees upon the shore of the lake,—
beneath those rustling boughs Helene has slept for a year. She died
in Elizabeth's arms, praying God to bless the dear sister who had so
helped her to bear her burden of woe until her spirit could soar away
from its frail mortal tenement.
Hollfeld has sold Odenberg, and no one knows in what corner of
the earth he hides his discontent at the overthrow of all his plots.

THE END.
 * * * * * * * *

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